Bank of Montreal will buy troubled Wisconsin lender Marshall & Ilsley Corp for $4.1 billion in an all-stock deal, the biggest in a series of deals in which Canadian banks have snapped up weakened rivals.

Canada's No. 4 bank said on Friday the deal adds to its position in the U.S. Midwest and more than doubles the branch network it runs through its Chicago-based Harris Bank unit.

It will issue about C$800 million ($792 million) in new shares to help fund the acquisition. That news drove BMO shares down 6.4 percent to C$58.11 on the Toronto Stock Exchange. Shares of M&I were up 18 percent at $6.83 in New York.

We're not rushing out and selling our (BMO) stock, said David Cockfield, who oversees about C$300 million at MacNicol & Associates Asset Management Inc and who said the share dilution was the reason for the steep fall in BMO's stock price.

We do believe that there are probably some real deals out in the U.S. system and we hope that BMO has been able to identify one of them.

Canadian banks emerged from the global financial crisis in much better shape than many rivals and have been seeking growth opportunities abroad. The United States, with its still-fragile banking sector, is a key target.

Milwaukee-based M&I is Wisconsin's biggest bank, and the deal would create the 15th-largest banking group by assets in the United States, BMO said.

M&I has 374 branches and about $52 billion in assets. BMO has 321 U.S. branches and $110 billion in U.S. assets.

In addition to more than doubling BMO's U.S. branch network, the deal doubles its customer base in personal and commercial banking, gives it a position in additional U.S. cities, and builds up its U.S. wealth management business.

BMO said it should generate annual cost savings of about C$250 million by the end of fiscal 2013.

FULLY VALUED

Under the deal, each M&I share will be exchanged for 0.1257 of a share of BMO. Based on BMO's Thursday closing price of C$62.05, that values M&I at $7.75 a share, a 33.9 percent premium on Thursday's New York market close.

The $4 billion is not only a significant premium to the share price of the target, but there is likely to be some further capital that needs to be added to the asset, so that makes it even more pricey, said Juliette John, lead manager of the C$494 million Bissett Dividend Income Fund in Calgary.

She called the purchase price fully valued.

BMO will also purchase M&I's Troubled Asset Relief Program preferred shares at par plus accrued interest, with full repayment to the U.S. Treasury before the deal closes. It will also buy existing M&I warrants held by the U.S. Treasury.

The bank owed $1.7 billion to the government under the Troubled Asset Relief Program. BMO has accounted for $4.7 billion in expected future losses on M&I's loan portfolio.

John said the deal seemed like a good one from a strategic point of view, but that with serious integration issues ahead, only time will tell if it truly adds long-term value.

M&I has not turned a profit since the third quarter of 2008, after suffering from an ill-timed foray into areas like Las Vegas and Phoenix.

According data from Deutsche Bank analysts, M&I has far more commercial real estate and construction loans on its books than most of its peers, in percentage terms.

MORE TROUBLED BANKS LIKELY TO BE IN PLAY

Bank investors saw M&I's sale as a positive sign for troubled banks, indicating that other lenders could sell themselves at a premium. Shares of Synovus Financial Corp , a Columbus, Georgia-based bank that has not turned a profit since mid 2008, rose 4.4 percent on Friday morning.

Even for certain stressed names out there, there's now the idea of optionality or an exit strategy at a premium. This is the first big bank deal we've seen in a while, and it's not a take-under, said R. Scott Siefers, a managing director at Sandler O'Neill and Partners.

Jeff Davis, bank analyst at boutique bank Guggenheim Partners, said U.S. financial sector deals are likely to pick up in 2011 unless the economy slides back into recession.

There are a lot of banks that are so severely challenged from an asset quality perspective, that is compounded by an environment ... depressed by weak real estate values and weak loan demands, that their ability to earn their way back to robustness is unlikely, he said.

Canadian banks, dubbed the strongest in the world in a Bank of International Settlements report, have been active global buyers.

Royal Bank of Canada , Canada's biggest lender, last month bought the Hong Kong wealth management assets of Fortis Bank after snapping up British fund manager BlueBay Asset Management for about $1.5 billion.

No. 3 bank Bank of Nova Scotia recently bought South America banking operations from both Commerzbank AG and Royal Bank of Scotland , and is establishing a fixed-income rates desk in London.

No. 2 lender Toronto-Dominion Bank has been adding to its U.S. retail bank network.

The appetite is there to acquire and we'll likely see more deals, but not in the same size as this one, John said.

($1=$1.01 Canadian)

(Additional reporting by Pav Jordan, Maria Aspan, and Dan Wilchins; Editing by Frank McGurty, Janet Guttsman and Peter Galloway)